Cincinnati Bell – p3

IT Services and Hardware – IT services such as cloud hosting, VoIP phones, network security, etc.

Within Entertainment and Communication (E&C), it is further segmented into:

Consumer – bundled internet and TV packages offered to consumers

Enterprise – internet services to businesses

Carrier – leasing of internet pipes to wireless carriers

Simplistically, one can think of the Entertainment & Communication segment as TV and internet, and the IT Services are the additional services such as VoIP phones (that run on that internet circuit). In considering asset value, it is more informative segmenting Cincinnati Bell in terms of its technologies (DSL vs. Fiber), as oppose to their consumer or enterprise segments.

In Appendix G, we include an Introduction to Digital Subscriber Line Landscape for those want some background. We think the current wave of subscribers switching from DSL to cable is both very real and will likely accelerate in the near-term. However, this switch in technology will take longer than expected and DSL assets will continue to have value over the next 5-10years. When the value in Cincinnati Bell’s DSL assets start to stabilize, the focus shifts to its fiber assets.

We offer a brief Introduction into the Fiber Landscape in Appendix H. We take a deeper dive into this by looking at Cogent, a pure play fiber provider in Appendix I. Over the past decade, the cost of bandwidth has been coming down at staggering rates. This called into question the sustainability of firms like Cogent. Thus far, many have been surprised of the robustness of demand. We think this trend will continue to prove the skeptics wrong.

In Appendix J: Fiber Supply vs. Demand, we take a longer-term view and propose where we think supply and demand will be a decade from now. Here we conclude that wireless is not a substitute technology to fiber, but rather connected technologies. A decade from now we expect technology could have as much as a 10x multiplying effect on the supply. However, demand will vastly outpace the supply, driven by content richness and the number of devices. This idea is core to our thesis.

PART IV: CINCINNATI BELL’S FIBER BUILD OUT

A transformative fiber optic networks is in progress. Over the past few years, Cincinnati Bell has spent around half a billion dollars in building out its “Fioptics” fiber network. This Fioptics investment represents a significant amount relative to their size. As a percent of their Property Plant & Equipment, it is approximately 50%. This contrasts with CenturyLink which is less than 20%, assuming a similar weighting of fiber to maintenance capital expenditures.

Fioptics sales have been growing at a nice 30%+ annually and its contribution to total sales have more than doubled. This sales figure however is misleading. It is a poor representation of the longevity of its future cash flows. The earning potential of the fiber assets should increase for the next decade but will remain useful even further. Currently, cable has taken the majority share of residential internet due to its technical superiority. Fiber is and will continue to offer a path back into the residential market.

“The business case for FTTP has improved dramatically over the past few years, with costs falling significantly. Ten years ago, Verizon’s cost to deploy FTTP was roughly $1,500 per home passed, plus another $1,500 per home to connect. Cincinnati Bell and CenturyLink have recently estimated the cost per home passed at $500–700, almost one-third of what it used to be.” (Ovum)

A better metric for Cincinnati Bell’s Fioptics success is their subscriber count. Over the past few years CBB has been able to grow subscribers at around 25%+ y/y versus the national fiber average about 15% y/y (4% broadband subscriber growth y/y). Looking into the near-future, the cost of deploying fiber will continue to come down, while the addressable market will continue to expand.

In Ohio, Indiana, and Kentucky, fiber penetration rates are low relative to the national average. This offers favorable opportunities for organic growth.

“Passing” measures how many potential customers the fiber network exposes CBB to. For example, if you owned the fiber assets along a street with 20 homes, your “passing” would be 20. CBB’s passing has expanded from 276 thousand homes at the end of 2013 to 533 thousand homes at the end of 2016. Additionally, the number of Fioptic internet subscribers relative to the Total Passing has been improving every quarter. What is important to note here is absent an investment in new construction, growth can come from increasing penetration.

In thinking about the long-term margins of fiber, we can use Cable as a lower bound benchmark. Most cable providers are around the forty percent EBITDA margin at maturity. This margin assumption is also consistent with the valuation built into pure fiber providers like Cogent. However, it would be wise to exercise some caution on margin potential looking into the future. Specifically, as the industry evolves into a more horizontal structure, competition should drive margins down. This is further discussed in the section on Industry Structure. Additionally, CBB’s primary competitor in the cable space is Time Warner Cable (now owned by Charter Communications), and run by a true visionary that needs no introduction.

Finally, it is worth considering how fiber deployment has played out historically. How did fiber compete vs. cable in 2007? Looking at Net Subscriber Adds between 2007 and 2012, it is clear cable ‘net subscriber adds’ beats out DSL’s ‘net subscriber adds’ during the same quarter. However, when Telcos added video (bundled in a Fiber offering), it consistently beats out cable. We are seeing this pattern reoccur now and probable to assume it will continue into the near-future. To further emphasize, this does not even consider the benefits of latency that fiber offers because the use cases have not yet emerged.